The National Cabinet’s mandatory Code of Conduct (Code) was released last week. The Code is a set of principles that apply to eligible commercial tenancies including retail, office and industrial. The principles will act as a guide for parties to negotiate amendments in good faith to existing leasing arrangements.
For how long does the Code apply?
The Code will shortly be formalised by the enactment of legislation or regulations by the States and Territories. The Code comes into effect in all States and Territories from a date following 3 April 2020 (to be defined by each jurisdiction) and will remain in place for the period during which the Commonwealth JobKeeper program remains operational.
Who does the Code apply to?
The Code is mandatory and applies to all landlords and tenants if the tenant fulfills both of the following conditions:
it is a small or medium size enterprise with an annual turnover of less than $50 million per year. It is not clear at what point in time the $50 million assessment of annual turnover occurs. However, given that much of the legislative change and rescue packages are directly linked to Commonwealth Government’s JobKeeper program, our view is that the annual turnover assessment made by the ATO as part of an application for the Commonwealth Government’s JobKeeper program, will be the test applied to the Code.
it is suffering financial distress and hardship. We note that this phrase is defined so that tenants eligible for the JobKeeper program automatically qualify. Businesses with an annual turnover less than $1 billion are eligible for the JobKeeper program if they have experienced a 30% fall in revenue since 1 March 2020, and are not subject to the major bank levy.
Although not mandatory for other tenants, the National Cabinet have expressed a desire for the Code to nonetheless be applied to all leasing arrangements for businesses affected by COVID-19. The Code is intended to apply during the period of the COVID-19 and a reasonable subsequent recovery period (Code Period).
The following are the key principles that landlords and tenants must consider in negotiating amendments to existing leasing arrangements:
Good faith: All negotiations must be in good faith.
Collaboration: Parties should work together to ensure business continuity and to facilitate resumption of business after COVID-19. This includes reaching mutually appropriate temporary leasing arrangements through open and transparent sharing of relevant information and assisting in dealings with other stakeholders such as banks and governments.
Regard to COVID-19 implications on business: Agreed arrangements between parties must account for COVID-19’s impact on the tenant’s business including revenue, expenses and profitability. Consideration must be had to whether the tenant is in administration or receivership.
Unique arrangements: Arrangements must be dealt with on a case-by-case basis, including determinations around rent and lease terms.
Principles specific to landlords
The following are principles that landlords are obliged to follow as soon as practicable and on a case-by-case basis:
Landlords must not terminate leases due to non-payment of rent during the Code Period.
Whilst the Code does not prevent termination of leases for other breaches, landlords should take into account the overarching principles of the Code before taking such action.
2. Rent reductions, waivers and deferrals:
Landlords must offer tenants proportionate reductions in rent in the form of waivers and deferrals of up to 100% of the amount ordinarily payable. Rental waivers must constitute at least 50% of the total reduction in rent payable, although this may be waived by the tenant. A case study of how the rent reductions work is outlined at the end of this article.
Importantly, rental waivers may need to be greater than 50% if that is required to ensure the tenant has the capacity to fulfil its ongoing obligations under the lease. However, any such increase to the rental waiver must take into account the landlord’s financial position.
Rental deferrals must be amortised over, whichever is greater between, the balance of the term and the period of no less than 24 months. The repayment period cannot commence until the earlier of the end of the Code Period and the expiry of the lease.
No fees, interest or other charges may be applied with respect to rent waived but the Code contemplates allowing interest to be charged on deferrals of rent provided the rate is not punitive.
The landlord must provide the tenant with an opportunity to extend the lease for a period equivalent to the rent waiver and/or deferral period. However, the reverse position is not contemplated by the Code, meaning landlords cannot require tenants to extend lease terms in return for the waivers and deferrals of rent.
3. Passing on benefits: Landlords must seek to pass on to tenants the benefits received, including:
any reduction in charges such as land tax, council rates and insurance (in the appropriate proportion determined with respect to the lease). This will result in a net position for landlords where leases allow for recovery of outgoings, but it is unclear how it is to be applied to tenants paying a gross rent; and
benefits it receives due to deferral of loan payments, including those provided by a bank or other financial institution. To this end, the New South Wales and Queensland Governments have announced that their respective legislative enactments will provide for a 25% discount on land tax for the 2020 calendar year which will be passed on to tenants as a form of rent relief. Further details will be provided as the legislative landscape evolves.
4. Security / bank guarantee: A landlord cannot call on a tenant’s security during the Code Period for non-payment of rent, including any claim on cash bonds, bank guarantees or personal guarantees. The Code does not prevent landlords calling on security in respect of other breaches but it is possible the legislation may extend the prohibition.
5. No rent increases: Landlords must agree to a freeze on rent increases for the Code Period (except for retail leases based on turnover rent).
6. Other key considerations:
Tenants may reduce opening hours or cease trading without being in breach of their leases. Landlords may not impose any levy or penalty if tenants reduces opening hours or cease to trade due to COVID-19.
Landlords should, where appropriate, seek to waive recovery of any other expense or outgoing during the period which the tenant is unable to trade. Landlords reserve the right to reduce services as required in such circumstances.
If negotiated arrangements pursuant to the Code require repayment, the repayment must occur over an extended period to avoid undue financial burden on the tenant.
7. Principles specific to tenants: Tenants must abide by the terms of the lease, subject to any amendments made under to the Code.
8. Conflict resolution: Where landlords and tenants cannot reach an agreement, the matter will be referred for binding mediation to the applicable State or Territory retail/commercial leasing dispute resolution process, including Small Business Commissioners and Ombudsmen.
Practical Considerations Pending Introduction of State Specific Legislation
Whilst it remains to be seen how the Code will be reflected in the jurisdiction specific legislation, it is worthwhile landlords and tenants considering a range of matters at this stage, including those outlined below.
Landlords should consider the following:
1. Reviewing its tenancy portfolio to form an initial view as to which tenancies are likely to be caught by the Code.
2. Considering what information should be requested from those tenants who apply for rent relief in order to assist the landlord in considering the appropriate waivers and deferrals of rent. 3. An assessment of the likely impact of waivers and deferrals of rent on the landlord’s revenue and the resulting impact on the landlord’s business, including the landlord’s ability to meet its own financial commitments.
4. Assessing the landlord’s obligations under the Code against its other legal duties and obligations (including director’s duties, duties to shareholders/unitholders).
5. Considering the implications of the insolvency laws and the interplay with the requirements of the Code.
6. Considering the implications of any rent reduction arrangements on the landlord’s financing (including potential need for financier consent to any lease variations).
7. Preparing revised cash flow budgets, based on rent reductions to be granted to tenants, and approaching the landlord’s financier to discuss variations to the finance arrangements to minimise the financial impact on the landlord (such as reduced interest rates and deferred mortgage installment repayments).
8. Considering if it has the resources needed to:
properly analyse the information received from tenants requesting rent relief.
model the form and financial impact of any rent relief and to negotiate numerous individual lease arrangements across its portfolio; and
document agreed lease variations in a timely manner (and to register those documents in jurisdictions where that is required).
9. Considering whether potential extensions of lease terms are likely to impact on the landlord’s intended use of the property (e.g. proposed redevelopment).
10. Ensuring the timely integration of agreed rent reductions and rent freezes into the landlord’s or its property manager’s accounts systems.
11. Considering the landlord’s rights to enforce lease provisions pending the implementation of the legislation in the relevant jurisdiction (including in relation to any existing breaches).
12. Undertaking an audit of all security deposits and bank guarantees held by the landlord to ascertain the expiry dates, if any, of the bank guarantees and to ensure the landlord’s interest in any security deposits have been registered.
13. Considering if tenants should be required to replace any bank guarantee containing an expiry date (to ensure expiry does not occur until the later of the end of the Code Period and the date all rent deferrals are required to be repaid).
14. Considering cost savings (such as reduced security costs, services and cleaning) but taking into account landlords’ obligations under legislation to provide or maintain these services.
Tenants should consider the following:
1. Assessing whether the Code applies to the tenant.
2. Ensuring all turnover information is up to date and gathering information necessary to demonstrate to landlords that the Code applies to the tenant, including information to evidence the reduction in the tenant’s turnover.
3. Considering the nature and form of the rent reduction required to sustain the tenant’s business during the Code Period and into the future.
4. Ensuring that any requests for rent reductions are proportionate to the reduction in the tenant’s turnover.
5. Unless otherwise permitted under the Code (or agreed with the landlord), ensuring continued compliance with the provisions of the lease (failure to do can result in the loss of the protection provided under the Code).
6. Where the Code does not apply to a tenant, but the tenant’s business has been affected by COVID-19, opening discussions with landlords seeking co-operation within the spirit of the Code.
7. Ensuring it has the resources and expertise needed to gather the information needed to apply for Commonwealth Government’s JobKeeper program and to negotiate lease variations with landlords.
Case study: rent reductions
If a tenant can establish it is experiencing an 80% decrease in turnover as a result of measures taken to deal with the COVID-19 pandemic (determined based on reduction of trade during the Code Period and subsequent reasonable recovery period) it would be entitled (in principle) to a reduction in the corresponding rent by 80%, with at least half of this reduction being a permanent waiver. So, if the tenant’s monthly rent was $100,000, rent would be reduced by $80,000 to $20,000 each month during the Code Period.
In relation to the $80,000 reduction:
$40,000 is permanently waived each month of the Code Period by the landlord; and
$40,000 is deferred each month (repayable over the greater of the balance of the term and 24 months after the Code Period (except as otherwise agreed).
About Hamilton Locke
Hamilton Locke is a corporate law firm specialising in complex corporate finance transactions, including mergers and acquisitions, private equity, finance and restructuring, litigation, property and fund establishment.
If you would like to discuss the contents of this article or have any questions about the impact of current events on your business, please contact John Frangi, Partner (email@example.com), Marcus Cutchey, Partner, (firstname.lastname@example.org) or Brendan Ivers, Partner, (email@example.com).